The Path to Homeownership: How to Save for a Down Payment

Are you a first-time home buyer eager to transition from renting to owning a home? If the answer is yes, understanding how to save for a down payment is an important step toward achieving your dream. In this article, we provide a look at what a down payment is, how to know how much to save, and some practical tips on how to save for this pivotal step toward home ownership.

What is a Down Payment?

The idea of buying a home is exciting, but it requires a significant financial commitment. One of the most substantial expenses you'll need to prepare for is the down payment. Your down payment is a lump sum payment made upfront when you buy a house. It directly affects the mortgage amount you'll need to borrow and the size of your monthly payments.

A down payment is generally expressed as a percentage of the purchase price of the house. For instance, if a home costs $300,000, and you're expected to make a 20% down payment, that means you need to save $60,000.

Why is Down Payment Important?

The size of your down payment matters. A higher down payment means smaller monthly mortgage payments and potentially better mortgage terms. Conversely, according to the Consumer Financial Protection Bureau, a down payment of less than 20% when you're getting a  conventional loan often means you'll have to pay private mortgage insurance (PMI). PMI is an additional cost that protects the lender if you default on your loan¹.

How Much Do You Need to Save For a Down Payment?

The amount you need to save for a home down payment can vary based on several factors, including the price of the house that you want to buy, the type of loan you choose, and your financial situation. Don Fowler, Sr. Loan Officer at Movement Mortgage says that lenders typically expect a down payment ranging from 3% to 20% of the home's purchase price. However, if you're a first-time home buyer, certain loan programs may require a smaller down payment.

For example, if you're aiming to buy a house priced at $300,000 and you qualify for a loan program that requires a 3.5% down payment, like an FHA Loan, you'd need to save $10,500.

Remember, the more you save for a down payment, the less you'll need to borrow, and the lower your monthly payments will be. A mortgage calculator can be helpful in determining the potential cost of your mortgage and monthly payments based on different down payment amounts. It allows you to input various factors, such as the home's price, your down payment, the loan term, and the interest rate, to estimate your monthly mortgage payments. In addition to calculating your potential mortgage payment, many calculators can also factor in additional costs, such as property taxes and homeowners insurance. This can give you a more accurate picture of your total monthly housing cost.

Tips for Saving For a Down Payment

Once you've established your savings goal, the next step is to figure out how to save toward your down payment. While that process is not one-size-fits-all, here are some tried and true ways to save to get you started.

Figure out where to store your down payment fund

A traditional savings account is one option, but it may offer a low-interest rate. Alternatively, a high-yield savings account or a money market account could provide a higher return on your savings while still being insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA).

Develop a budget

There is no better tool for helping you to start saving for a house and achieve your goal of home ownership than developing and maintaining a budget. Whether you use pen and paper, a spreadsheet, an app, or some other type of online budgeting tool, the first thing you'll want to do is list all of your non-negotiable, basic living expenses that you need to pay every month. At the very least, these will probably include such things as rent, food, utilities, and transportation costs. Then add in all of the ways that you're currently spending the rest of your money and see if there are some ways to cut expenses.

Based on that, you should be able to determine the amount of disposable income that you have and the amount you can put toward your house down payment each month. Then include that amount as a line item in your budget, so that you start thinking about it as one of your non-negotiable expenses.

Here's an example of how quickly that can add up. If you tighten your financial belt and find that you have $1,500 in discretionary funds each month and save that money for a house, you'll have a $60,000 down payment saved up in just under 3.5 years.

Keep in mind, your down payment is not the only expense you'll need to save for when you plan to buy a house. Closing costs, home inspections, moving expenses, and potential repairs or upgrades are additional costs you'll likely have to cover. You'll want to make sure that you add these in when determining how much you want to save.

***Important note: Be sure that you save some of your disposable income for an emergency fund. You also want to make sure that you're contributing to a retirement account.

Automate savings

Once you know how much you can save each month toward your down payment goal, automate your savings. Setting up automatic transfers to your down payment savings account can eliminate the temptation to spend the money on other things. Plus, it ensures that you're consistently contributing to your savings goal. You can do this in a couple of ways.

• Set up a split direct deposit through your employer. Check with your payroll department to see if your employer offers split direct deposit. This lets you designate either a percentage or dollar amount from each paycheck that can be directly deposited into your savings account².
• Make automatic payments into your savings account. If your employer doesn't offer the ability to make a split direct deposit, you can do this yourself. Through your bank, you can schedule recurring, automatic transfers to your savings account from your checking account. You can do this each month or on each pay day. That way you don't even see the money in your account. Out of sight, out of mind!

Put one-time sources of income toward your savings

When considering ways to save money for a down payment, don't forget about one-time sources of income. These could include tax refunds, birthday money, Christmas money, working overtime, etc. If you're getting married, ask your guests to consider contributing toward your house fund as their wedding gift. An easy way to do this is through such services as Honeyfund, Zola, or The Knot.

Making the Dream of Home Ownership a Reality

Saving for a down payment is an important step in the journey to home ownership. By determining how much you need to save, setting a savings goal, choosing the right savings account, and implementing practical savings strategies, you can successfully save for a home down payment. This process requires discipline, patience, and perseverance, but with a clear plan and determination, you can achieve your goal of owning a home

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Our agents or other trusted local experts answer your questions every month through the Ask a REALTOR® series. If you have a real estate question that you want answered, we’d love to hear from you at marketing@westandwoodall.com.

Sources

1. Consumer Financial Protection Bureau. What is Private Mortgage Insurance?
2. Bankrate. Split direct deposit: a simple way to save more money.